Samsung’s record profits mask looming crisis

Virtual reality is one of the areas Samsung is exploring as it looks to diversify its revenue streams and capitalise on its chipmaking expertise © FT montage / Bloomberg

When Samsung Electronics was crowned the world’s most profitable technology group this summer, it was a watershed moment in the company’s history — marking a decades-long transformation from a purveyor of cheap consumer goods into a global household brand.

On Friday, the company signalled its hot streak would continue, estimating record-breaking profits for the third quarter of Won14.5tn ($12.8bn) — a near-tripling from the same period a year earlier.

But there was immediate concern about the future as well, with a generational change in leadership signalled by the shock resignation announced by chairman of the board Kwon Oh-hyun, who also leads the group’s most successful division — semiconductors.

“As we are confronted with [an] unprecedented crisis inside [and] out, I believe the time has now come for the company [to] start anew, with a new spirit and young leadership,” Mr Kwon said. He was referring to the internal management problems created by the incarceration of the group’s de facto leader Lee Jae-yong on corruption charges last month, as well as the external challenge where Samsung, in his words, was “not able to even get close to finding new growth engines by reading future trends right now”.

The group — the jewel in the crown of the Samsung conglomerate — has outlined its ambitions in a host of cutting-edge technologies, including artificial intelligence, autonomous driving as well as internet-connected homes and appliances.

But analysts remain cautious, with many concerned about the smartphone maker’s ability to make important long-term decisions following the imprisonment of its chief.

“There is a big question over Samsung’s long-term growth potential,” said Kim Young-woo, an analyst at SK Securities. “Investors are in the dark about Samsung’s new growth drivers as the company is not presenting any blueprints, especially since Lee Jae-yong got imprisoned.”

Although better known for its Galaxy smartphones, Samsung’s record profitability was fuelled by savvy investments in chipmaking years ago by Lee Kun-hee — the father of Lee Jae-yong and nominal Samsung chairman. 

Today, the sector is in the midst of an industry “supercycle” amid soaring demand for ever more powerful mobile and internet-connected devices. This summer, the South Korean group ended Intel’s quarter-century reign as the world’s biggest chipmaker, profiting handsomely along the way from surging prices for its Dram and NAND memory chips.

Now, many believe Samsung can, at least in the medium-term, ride this momentum and potentially use its chipmaking prowess to segue into new growth areas.

“Its memory business outlook is very good. Samsung can actually advance into new areas, leveraging its strength in the existing chip business, as we embrace a new era where memory capacity will be really important,” said Marcello Ahn, a fund manager at Quad Investment. 

“Global tech titans such as Google, Amazon and Facebook will all need more and more customised chips from Samsung as they build large-scale, high-functioning data centres. They will be in desperate need of help from memory chipmakers for bigger storage capacity and differentiated cloud services,” he added.

The recently launched Note 8 has perfomed better than expected and is likely to sell 10m units this year © Reuters

Samsung’s strength in chipmaking is also likely to aid its ambitions in the field of autonomous driving.

Lee Seung-woo, an analyst at Eugene Investment and Securities, estimates that by 2020, autonomous driving will require 4,000 gigabytes of data per car per day, which “means huge memory capacity”.

“Taking advantage of its chip technology, Samsung should focus on the necessary components for data storage, rather than on self-driving technology itself,” Mr Lee says.

Samsung says it does not intend to manufacture its own autonomous vehicles. The company has, however, been testing self-driving software adapted to Hyundai cars on roads in South Korea and California.

In a high-profile deal last year, the Seoul-headquartered group also bought out US automotive component supplier Harman International — a move that Samsung believes will give it an edge in internet-connected car technologies. 

“In the future, a car will be a high-functioning computer server with wheels. Samsung is preparing to become a major player in the autonomous driving era, although the new business is unlikely to generate sales immediately,” said Peter Yu, an analyst with BNP Paribas.

“Autonomous driving will require huge data processing power and Samsung can provide essential components including sensors, storage chips, cameras and display,” he said, adding that growing use of infotainment systems would fuel demand for Samsung’s OLED curved display panels.

The company says it will continue to invest in R&D, pointing to a more than $12bn outlay last year, while making investments to acquire new capabilities.

However, many analysts remain deeply sceptical about whether Samsung has the competencies to pursue a software-driven business, such as autonomous driving or internet-connected home appliances.

“To develop artificial intelligence and ‘Internet of Things’ technologies, Samsung needs to acquire competitive software makers to make up for its weakness in the area. But it is hard to expect any large-scale M&A so long as Mr Lee remains in jail,” said Mr Kim of SK Securities.

Such remarks reverberate around South Korea, where many believe the conviction of Lee Jae-yong could undermine decision-making at a company renowned for its “emperor-like” mode of management.

“This must be a very scary moment for Samsung executives. They’re alone now,” said Kim Woo-chan, a business professor at Korea University, alluding to the reluctance of Samsung’s top brass to make executive decisions. 

Mr Lee, the billionaire vice-chairman of the conglomerate, was in August sentenced to five years in prison for bribing the country’s former president, Park Geun-hye. Days after the sentencing, a top executive admitted “various troubles related to rolling out investment for the future”.

“The tech industry will change so fast in the coming years. The changes over the next couple of years will come faster and be more drastic than those over the past decade,” said Mr Yu of BNP Paribas.

“So it will be difficult for Samsung to cope with such rapid changes through only organic growth. More and quicker M&A is needed to embrace the fast-changing environment and Samsung needs a control tower to lead and co-ordinate . . . tech development.”

The company said that Mr Lee was “not involved in day-to-day operations but has played a key role in the company’s strategic decision-making related to future growth and business alliances.” 

Meanwhile, Samsung’s mobile business has recovered quickly from a high-profile debacle last year when it terminated its marque Note 7 device after handsets around the world caught fire.

The division is forecast by analysts to report an operating profit of Won3.1tn in the third quarter, compared with just Won100bn a year earlier — due then to the haphazard recall and subsequent termination of fire-prone devices. 

It posed $3.5bn operating profit in the second quarter on strong sales of the flagship S8 smartphone, while the recently launched Note 8 has performed better than expected and is likely to sell 10m units this year.

This post originally appeared on Financial Times

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